Financial consumer protection is not a destination, it’s a journey

The global financial turmoil which commenced in 2008, revealed that the absence of efficient and effective consumer protection measures were significant causal factors in destabilising financial systems and undermining public trust in financial services

Human greed for the wealth is not a recent phenomenon. It has been there ever since the existence of mankind on earth. People’s greediness for money makes them vulnerable to undertake various fraudulent transactions, scams and deal in unauthorised financial products. 

When the people’s financial literacy level is poor their vulnerability to such incidents is exacerbated. In fact, the information asymmetry in financial markets leads to consumer exploitation. The absence of an effective framework for financial consumer protection has adverse impacts on financial system stability as well. 

According to John F. Kennedy, “A consumer by definition includes us all. They are the largest economic group in the economy, affecting and being affected by every public and private economic decisions.” 

The growing number of complaints, protests and allegations by customers of banks and finance companies, in Sri Lanka, highlights the importance of having a comprehensive framework to safeguard their rights. Similar to the financial regulatory architecture in Sri Lanka, the consumer protection framework of the country is also fragmented. 

The Securities and Exchange Commission is vested with the powers to protect investors in the capital market and the Insurance Board of Sri Lanka has devised a framework for protecting insurance policyholders. This article addresses the consumer protection mechanisms applicable to licensed banks and finance companies in the context of rapidly-evolving financial markets and products. 

Impact of the lack of financial literacy

The global financial turmoil which commenced in 2008, revealed that the absence of efficient and effective consumer protection measures were significant causal factors in destabilising financial systems and undermining public trust in financial services. 

Fraudulent practices such as mis-selling of subprime mortgages in the USA had a contagion effect on many other markets. Technological advances, financial product innovations and market developments have come a long way since the financial crisis in 2008. The Sri Lankan financial services industry is also experiencing challenges emanating from fintech developments. 

This rapidly changing environment can lead to abuse consumer rights unless financial entities comply with relevant rules and regulations and consumers are empowered to make sound financial choices confidently. The financial capability of citizens can be enhanced through a broad-based program of financial education and information.

From ancient times, in Sri Lanka, people complained about their grievances to the king. This practice is still being followed even in relation to the complaints against banks and other financial services providers. People write to political authorities requesting loan rescheduling, reducing interest rates, implementing loan moratorium and suspending legal actions such as parate execution. 

It reveals two weaknesses in the current financial landscape. One is lack of awareness of customers about the due procedures in complaining against financial entities. The other is the lack of a transparent and comprehensive complaint redress framework for financial consumers. This has caused delays in resolving complaints and tarnishing the images of individual financial entities and the regulators.

Financial consumer protection goes hand in hand with financial inclusion and financial education. People can reap benefits from enhanced access to responsible finance, only if they are aware of the basic features of relevant services. In terms of the regulations issued by the CBSL, licensed banks and finance companies are required to publish audited financial accounts. 

However, people still find it difficult to assess the financial soundness of those institutions due to a lack of ability to analyse such information. Some people, who deposited their hard earned money in entities like Golden Key Credit Card Company and other unauthorised institutions, had not been aware of the requirement to check whether those entities had due authority to accept their life savings. Commencing financial education from the school level will, therefore, be more effective in empowering consumers to take informed decisions. 

The Econ-Icon Program conducted by the Central Bank of Sri Lanka (CBSL) is an example of a positive step in this direction. Enhanced consumer awareness will lead to promote healthy competition in the financial markets as well. Batunanggar states (2019) that financial literacy can make a change not only in individuals’ lives but in the integrity and the quality of markets.

Rationale of financial consumer protection

Theories of behavioural economics suggest that consumers get trapped in behavioural biases when making decisions. The rationale of financial consumer protection is ensuring that there will be no space for deception and discrimination which will restrict productive economic opportunities for customers. According to the G20 High Level Committee Principles on Financial Consumer protection, consumer confidence and trust in a well-functioning market for financial services promotes stability, growth, efficiency and innovation over the long term. Comprehensive knowledge on the part of a consumer regarding financial products prevents him/her from taking sub optimal decisions. 

The European Banking Authority (EBA) has suggested four key tips to be followed before a particular financial service or a product is chosen by consumers. They have advised the customers to identify the financial needs, collect information about the services and study it carefully, check whether it suits the financial needs and capabilities of the customer and compare offers from different financial service providers. Rational choices of financial products or services will contribute to improve purchasing power of consumers, enhance consumer welfare and promote shared growth.

Only a consumer who possesses a thorough knowledge on financial products can comprehend risk and reward to undertake a careful selection. It has been observed that depositors of failed finance companies in Sri Lanka face grave difficulties as they under-diversify their investment portfolios due to poor financial literacy. They also chase higher returns without understanding the risks involved. 

However, regulations should not over burden financial entities as a result of which financial facilities to consumers may be discouraged. Providing customised advice to the clients in an ethical manner and protecting the integrity of employees should also be emphasised under protection frameworks. Financial institutions can be compelled to be transparent regarding the long term sustainability of their products and services, if strong safeguard mechanisms are available.

Inderst and Ottaviani (2011) state that commissions paid by financial service providers to brokers would lead to biased advice. Given the high competitiveness in financial markets, bank employees are also given strict targets based on which their performances are evaluated. This could result in ill-advice to customers. Accounts opened by the employees of Wells-Fargo without the permission of customers is an example from the recent past for such unethical practices. 

Abusive procedures followed by formal and informal financial institutions in relation to micro finance loans reported from the domestic markets emphasise the requirement for responsible lending. A robust protection framework is, therefore, needed to insulate financial consumers from the aforesaid vulnerabilities and empower them with relevant skills and confidence to assess financial services in engaging in productive economic activities. 

Banker-customer relationship 

The banker-customer relationship is based on a contract. A long time ago an English Court in a Case titled “Woods V Martins Bank Ltd.” accepted that the banker-customer relationship is “fiduciary” in character. Accordingly, banks are required to comply with implied terms and conditions of a contract which require them to exercise a duty of care towards customers. Furthermore, there have been specific requirements introduced under modern banking regulations to ensure financial consumer protection.

The Financial Ombudsman scheme of Sri Lanka

The Financial Ombudsman is an alternative dispute resolution mechanism available for the customers of licensed banks and finance companies. This scheme has been established with the concurrence of the CBSL and the above mentioned institutions are voluntarily participating in the scheme. However, it is observed that due to a lack of awareness of this institutional mechanism people write to various other parties including political authorities when a dispute arises. 

Prior to any complaint being submitted to the Financial Ombudsman, it should be referred to the “Complaints Settlement Officer” or “Complaints Resolution Officer” of the relevant financial institution. It is, therefore, of paramount importance to have relevant procedures and policies in place in financial institutions to enable consumers to submit their complaints accordingly as the first recourse and to minimise the response time.

Customer Charters of licensed banks and finance companies

The CBSL has, in terms of the powers vested with it under the Banking Act No 30 of 1988 and the Finance Business Act No. 42 of 2011, issued Customer Protection Frameworks to safeguard the rights and interests of financial customers. However, it is also observed that customers are not fully aware of these frameworks and even employees of financial entities have very limited knowledge about the said mechanisms. 

The salient obligations of the licensed banks and finance companies under the said Customer Charters include providing factual information to customers, providing such information in languages preferred by customers, facilitating customers to understand the “Terms & Conditions” attached to products/services, displaying key information such as interest and exchange rates and protecting customers from abusive debt collection practices.

Aforesaid requirements are helpful to ensure that accurate, simple and comparable information related to a financial product or service is available to customers before and after purchasing them. Such protection will enable customers to play a central role towards the development of the market place as a depositor, saver and borrower. However, disclosure requirements should not be a mere ‘tick the box’ exercise which will overload information. The need to make available only the information which is relevant to take optimal decisions should be emphasised in this regard.

Customer Charters also stipulate the measures for efficient and effective dispute resolution mechanisms. Financial institutions are also required to establish a management information system regarding customer complaints. Analysing recurrence of similar complaints would help financial institutions to rectify defects in their services and products. Compliance with these regulatory requirements by financial institutions will eventually contribute to strengthen the consumer protection framework of the country.

Protecting consumer rights through responsible innovation

The way people borrow, make payments, invest and manage wealth has been changed through the rapid and extensive technological innovation in financial services sector. The use of technology in financial products and services is considered as “fintech”. 

Saunders (2019) states that the allure of shiny fintech products must not lead us into waiving consumer protection rules or oversight of untested products. Innovations contribute to lower transaction costs and promote inclusion. At the same time, they carry risks as well. The global financial crisis revealed very vividly that consumers had not been fully aware of risks associated with some complex financial products. 

The digitalisation wave is sweeping across financial products and facilities. Leading financial regulators, such as the Hong Kong and Singapore Monetary Authorities are opening up their banking industry to digital banks. Since the overhead costs for digital banks are much lower than physical branches, they can provide low cost innovative services to customers. Gaming Company Razer Grab and Singtel are some entities which have sought approval to secure digital full bank licenses. Sri Lanka should also be ready to face this digital transformation in an efficient and effective manner.

Financial innovations are changing the picture of what “banking” means to people. However, as aforesaid Fintech developments are not free from risk. Regulation Technology (regtech) can play a significant role in ensuring proper compliance and risk management frameworks in relation to Fintech products. Consumer protection approaches should also be evolved at the same pace as such technological development. 

Another key issue is that personal and transactional information is being collected, stored and shared by service providers through digital technology such as “big data”. Priority should, therefore, be attached to data protection and privacy as identity thefts and other cyber risks are also advancing with digitalisation.

This article suggests that financial consumer protection is not a destination, it’s a journey. In order to ensure effectiveness of consumer protection frameworks, they need to be aligned with the increasingly digital environment. 

In terms of an OECD (2017) study the emergent digitalisation of daily life and of financial decision is not necessarily matched by financial literacy levels. It has been found that this is even applicable to the young population. Poor understanding of risks associated with digital products will make consumers vulnerable to unfair and defective practices. Efficient and effective dialogue is, therefore, important between regulators and other stakeholders in identifying best practices for consumer protection in the context of emerging digital ecosystems. 

The event hosted by the Bank of Portugal titled ‘Pay Challenge: The Future of Payments and Fintech’ and the conference called “BaFin-Tech” conducted by the Federal Financial Supervisory Authority of Germany are such examples. 

Financial regulators will face the challenge of striking a delicate balance between being innovation-friendly and preventing criminal behaviour by financial service providers. As emphasised by the Office of Comptroller of the Currency of the USA, digital products need to be responsible innovations that improve lives while maintaining consumer protection.

Buyer beware (caveat emptor)

This is a Latin Phrase which indicates that the supplier has no legal obligation to inform buyers about any defects in his goods or services. This cannot be applied to financial services in the same theoretical approach mainly due to the poor financial literacy of consumers and the complex nature of products. However, consumers too have certain obligations in dealing with banks and other financial institutions. 

Gaining a thorough understanding of the products before entering into a contract, exercising due care in all transactions, immediately informing the bank of any fraudulent transactions and disclosing all relevant information and any changes relating to the clients are some of the legal obligations for customers in terms of the aforesaid consumer charters. 

Customers should pay special attention when engaging in electronic transactions, using mobile devices for transactions and handling private information, such as passwords and email addresses related to financial transactions. They too have an obligation towards responsible digital financial practices.

International experience of institutional arrangements for consumer protection

Before the global financial crisis, priority had been attached by the regulators to stability and financial soundness of individual entities. The crisis revealed that market conduct aspects had not been addressed under the prudential regulation. Therefore, financial consumer protection authorities have been established in various jurisdictions to regulate product design and financial innovation to prevent them being detrimental to consumer rights.

The Financial Conduct Authority of the UK is mandated to assess financial products and services for their reasonableness and suitability to customers. The Consumer Financial Protection Bureau of the USA has established a comprehensive legal framework for safeguarding consumer rights under the Dodd-Frank Wall Street Reform. The Consumer Education and Protection Department of India carries out the task of easing imbalances emanating from information asymmetries, inadequate disclosures and unfair treatment. 

In Ireland, the Competition and Consumer Protection Commission is involved in provision of personal financial information and comparison of financial products. The European Banking Authority is vested with the powers to promote a transparent, simple and fair market for consumers in financial products and services. In terms of the Code of Banking Practice, the Hong Kong Monetary Authority promotes good banking practices. The proposed Banking Act will pave the way for a strong financial consumer protection framework for Sri Lanka.

Conclusion

A robust consumer protection framework, coupled with comprehensive financial inclusion and education programmes, are vital for a stable financial system. More importantly, relevant and updated information needs to be made available to customers empowering them to make well informed choices of financial products and services, without being subject to deceptive practices. 

Financial literacy programmes need to be aligned with complex products and services emerging in the context of rapidly evolving technological advances. Regulators can also be benefitted when financial institutions follow a consumer-centric approach in handling their business affairs. Such an approach helps in deepening the financial system while preserving resilience. 

When consumer rights are well protected, public trust in the financial system is also enhanced. Priority should, therefore, be attached to efficient grievance redress mechanisms. Unjustifiable delays in replying to complaints will have adverse impact on the welfare of customers.

In strengthening consumer protection frameworks, building skills of employees of financial institutions is also of paramount importance. It will encourage a proactive approach for safeguarding consumer rights. Establishing proper institutional architecture with comprehensive mandates for implementing consumer protection framework is another priority. 

Efficient coordination between financial institutions, regulators, consumer protection authorities is also very vital in enhancing fair competition in financial markets. Special attention needs to be paid to protect customers from risks associated with digital transformation. Proportionate regulatory intervention is required to induce financial firms towards fair play in the context of speedy digital transformation. 

As stated by former US Federal Reserve Board Chairman Ben Bernanke (2009), imposing very strict conduct of business regulations would discourage innovations. He stated that regulators should “strive for the highest standards of consumer protection without eliminating the beneficial effects of responsible innovation on consumer choice and access to credit”. 

The CBSL is very much supportive in striking an effective balance between regulation and innovative digitalisation. The task of safeguarding financial consumers should not halt its progress being limited to “one size fits all” type of arrangements. Consumer protection frameworks created by the financial industry and regulators should continue the journey along with the new digital reality which involves an exponential acceleration in the pace of change.

(The writer, a Deputy Director, CBSL, Attorney-at-Law, can be reached at [email protected]. The views and opinions expressed in this article are those of the writer and do not necessarily reflect the official policy or position of any institution.)